Company Profile
Eastern Edison Company (Eastern Edison or the Company) is a retail
electric utility company. Eastern Edison supplies retail electric service to
approximately 184,000 customers in 22 cities and towns in southeastern
Massachusetts. The largest communities served are the cities of Brockton and
Fall River, Massachusetts. Eastern Edison is a wholly owned subsidiary of
Eastern Utilities Associates (EUA). EUA owns directly all of the shares of
common stock of Eastern Edison, Blackstone Valley Electric Company (Blackstone)
and Newport Electric Corporation (Newport). These EUA subsidiaries are
collectively referred to as the Retail Subsidiaries. Blackstone and
Newport are retail electric utility companies operating in northern Rhode
Island and south coastal Rhode Island, respectively. Eastern Edison owns all
of the permanent securities of Montaup Electric Company (Montaup), a generation
and transmission company, which supplies electricity to Eastern Edison, to
Blackstone, to Newport and to two unaffiliated utilities for resale. EUA also
owns directly all of the shares of common stock of EUA Service Corporation (EUA
Service), EUA Cogenex Corporation (EUA Cogenex), EUA Energy Investment
Corporation (EUA Energy), EUA Ocean State Corporation (EUA Ocean State), EUA
Energy Services Corporation (EUA Energy Services), and EUA Telecommunications
Corporation (EUA Telecommunications). EUA Service provides various accounting,
financial, engineering, planning, data processing and other services to all EUA
System companies. EUA Cogenex is an energy services company. EUA Energy was
organized to invest in energy related projects. EUA Ocean State owns a 29.9%
interest in Ocean State Power's two gas-fired generating units in northern
Rhode Island. EUA Energy Services owns an interest in a limited liability
company which markets energy and energy services. EUA Telecommunications
provides telecommunications and information services. The holding company
system of EUA, the Retail Subsidiaries, Montaup, EUA Service, EUA Cogenex, EUA
Energy, EUA Ocean State, EUA Energy Services, and EUA Telecommunications is
referred to as the EUA System. The Core Electric Business consists of the
Retail Subsidiaries and Montaup. See Electric Utility Industry Restructuring
for a discussion of changes taking place in the utility industry in the
territories served by EUA's Core Electric Business.
Form 10-K
A copy of EUA's, Eastern Edison's and Blackstone's Co-Registrant 1997
Annual Report on Form 10-K, which is filed with the Securities and Exchange
Commission, is available without charge by contacting us at:
EUA Service Corporation
Post Office Box 2333
Boston, MA 02107
(617) 357-9590
Internet Address
Visit EUA's Home Page on the worldwide web at: http://www.eua.com. MARKET FOR
EASTERN EDISON'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
All of Eastern Edison's common stock is owned beneficially and of record
by Eastern Utilities Associates (EUA).
The dividends paid on Eastern Edison's common stock during the past two
years are as follows:
Dividends Paid Dividends Paid
1997 Per Share 1996 Per Share
First Quarter $2.70 First Quarter $2.87
Second Quarter 2.70 Second Quarter 3.00
Third Quarter 2.70 Third Quarter 3.00
Fourth Quarter 2.70 Fourth Quarter 3.00
In January of 1997, a special common stock dividend was declared
and paid in the amount of $17
million.
No dividend may be paid on Eastern Edison's common stock unless
full dividends on Eastern Edison's outstanding Preferred Stock for
all past and the current quarterly dividend periods have been paid or
declared and set apart for payment, nor may any dividends be paid on
Eastern Edison's common stock if Eastern Edison is in default on any
sinking fund obligation provided for its Preferred Stock. See also
Notes C, D and E of Notes to Consolidated Financial Statements.
SELECTED CONSOLIDATED FINANCIAL DATA
For the Years Ended December 31,
(In Thousands) 1997 1996 1995 1994 1993
____________________________________________________________________________
Operating Revenues $435,014 $404,808 $420,069 $418,424 $417,021
Net Earnings 27,059 30,983 31,455 31,395 28,145
Total Assets 777,124 775,082 739,198 756,045 742,273
Capitalization:
Long-Term Debt-Net 162,491 222,402 222,313 229,224 264,134
Redeemable Preferred
Stock-Net 27,612 27,035 26,218 25,257 24,824
Common Equity 218,468 240,213 244,368 225,064 223,005
Total Capitalization $408,571 $489,650 $492,899 $479,545 $511,963
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND REVIEW OF OPERATIONS
Overview
Consolidated Net Earnings were approximately $27.1 million in 1997, a
decrease of $3.9 million or 12.7% as compared to 1996 Consolidated Net Earnings
of approximately $31.0 million. The 1997 results include the impacts of
increased jointly owned units expenses, primarily related to the extended
Millstone 3 outage, and increased expenses due to a June 1997 voluntary
retirement incentive offer (VRI) discussed below.
1996 Consolidated Net Earnings of approximately $31.0 million decreased
$0.5 million, or 1.5% compared to those of 1995 which included a one-time
charge of approximately $1.5 million, on an after tax basis, related to the
1995 VRI. The 1996 results were impacted by increased expenses related to an
unusual number of severe storms which struck Eastern Edison's service
territory during 1996 and increased legal expenses, partially offset by a
decrease in interest expense from debt issues that matured in 1995.
Comparison of Financial Results
Operating Revenues
Operating Revenues of approximately $435.0 million increased approximately
$30.2 million or 7.5% as compared to 1996. This change was primarily due to
increased recoveries of purchased power, fuel and conservation and load
management (C&LM) expenses aggregating approximately $23.2 million. Also
impacting revenues was increased base rate recoveries and increased short-term
contract demand sales.
Operating Revenues for 1996 decreased by approximately $15.3 million, as
compared to 1995. The change was primarily due to recoveries of decreased C&LM
and purchased power expenses aggregating approximately $14.0 million and
decreased contract demand sales of $1.6 million.
Voluntary Retirement Incentives
In June of 1997, an early retirement offer was accepted by a group of
employees who were eligible for, but not offered a VRI completed in 1995,
resulting in a charge of approximately $700,000 (approximately $500,000 after-
tax) to second quarter 1997 earnings.
Expenses
The Company's most significant expense items continue to be fuel and
purchased power expenses which together comprised about 59% of total operating
expenses for 1997. Fuel expense increased by approximately $18.6 million or
20.1% as compared to 1996. Outages of nuclear units in 1997 contributed to a
greater dependence on higher cost fossil fuels for energy requirements,
resulting in an increase in average fuel costs of 16.3% in 1997. Also
impacting fuel expense was an increase in total energy generated and purchased
of 4.6% in 1997 due mainly to increased sales to NEPOOL and increased short-
term unit contract energy sales. Fuel expense increased by $1.3 million or
1.4% in 1996 as compared to 1995 due to primarily to a 2.0% increase in total
energy generated and purchased.
Purchased Power demand expense increased approximately $600,000 or less
than 1% in 1997. This change is primarily due to increased billings from the
Pilgrim and the Maine Yankee Nuclear Units and the Potter #2 Fossil Unit
aggregating approximately $6.5 million. These increases were offset by
decreased billings from Connecticut Yankee and Ocean State Power Project (OSP)
of approximately $3.0 million and approximately $2.8 million, respectively.
Purchased Power demand expense decreased $6.8 million or 5.4% in 1996. The
decrease was due primarily to the impact of lower billings from the
Pilgrim nuclear unit of approximately $4.2 million which included a prior
period refund of approximately $2.0 million, and decreased billings from the
OSP and Maine Yankee aggregating $2.5 million.
Other Operation and Maintenance expenses (O&M) are comprised of two
components, Direct Controllable and Indirect. Direct Controllable expenses
include expense items such as salaries, fringe benefits, insurance,
maintenance, etc. Indirect expenses include items over which the Company has
limited short-term control and include such expense items as Montaup's joint
ownership interests in generating facilities such as Seabrook I and Millstone
3, power contracts where transmission rental fees are fixed, conservation and
load management expenses that are fully recovered in revenues and expenses
related to accounting standards such as Statement of Financial Accounting
Standard No. 106, "Employers' Accounting for Post Retirement Benefits Other
Than Pensions" (FAS106).
Other O&M expenses, including affiliated company transactions, increased
approximately $14.1 million or 15.3% in 1997. This change was primarily due to
increased jointly owned unit expense of approximately $9.0 million, of which
$5.0 million is related to the Millstone 3 outages and the remainder is due to
increased expenses related to the scheduled maintenance outages at the Canal
and Seabrook units. Also impacting the change was increased C&LM expenses of
approximately $1.8 million, increased legal expenses of approximately $1.3
million and $1.2 million of transmission expenses related to new transmission
tariffs implemented by FERC in 1997 to accommodate utility industry
restructuring. Other O&M expenses, including affiliated company transactions,
decreased by $4.8 million or 5% in 1996. The change was primarily due to
decreased C&LM expenses of $7.7 million, lower power contract and transmission
expenses of Montaup and effective cost control efforts aggregating $1.1
million. Offsetting these decreases somewhat were increases in storm related,
legal and jointly owned unit expenses aggregating $4.5 million.
Financial Condition and Liquidity
Eastern Edison's and Montaup's need for permanent capital is primarily
related to the construction of facilities required to meet the needs of
existing and future customers. For 1997, 1996 and 1995, Eastern Edison's and
Montaup's combined cash construction expenditures were $15.7 million, $26.0
million, and $23.4 million, respectively. Internally generated funds provided
approximately 123%, 118% and 236% of these combined cash construction
requirements in 1997, 1996 and 1995, respectively.
Cash construction expenditures are expected to be approximately $22.7
million in 1998, $16.1 million in 1999, and $14.5 million in 2000, and are
expected to be financed with internally generated funds.
In the utility industry, cash construction requirements not met with
internally generated funds are obtained through short-term borrowings which are
ultimately funded with permanent capital. In July 1997, several EUA System
companies; including Eastern Edison and Montaup, entered into a three-year
revolving credit agreement allowing for borrowings in aggregate of up to $120
million. As of December 31, 1997 various financial institutions have committed
up to $75 million under the revolving credit facility. At December 31, 1997
under the revolving credit agreement the EUA System had short-term borrowings
available of approximately $13.5 million. At December 31, 1997, Eastern
Edison had $4.7 million of outstanding short-term debt and Montaup had no
outstanding short-term debt.
In addition to construction expenditures, projected requirements for
maturing long-term debt securities through 2002 are $60 million in 1998 and $35
million in 2002. The Company has no sinking fund requirements through the
year 2002.
Electric Utility Industry Restructuring Initiatives
Unbundled Services:
The electric utility industry in both Massachusetts and Rhode Island, the
states in which EUA provides electric services, is transitioning from a
traditional rate regulated environment to a competitive marketplace.
Traditional electric utility services - generation, transmission and
distribution - have been unbundled into separate and distinct services. The
generation, or supply, function is now competitive with customers able to
choose their own electricity supplier at market prices. The transmission and
distribution functions remain regulated services. The local distribution
company is responsible for providing distribution services to the ultimate
electricity consumer within its franchised service territory and the
transmission company is required to provide open access, non-discriminatory
transmission services to generation or supply companies.
Stranded Costs:
Stranded costs represent prudently incurred costs of generation which are
now above their current economic value. In both Massachusetts and Rhode Island
(see discussions below) stranded costs have been defined to include items such
as above market net investments in generation assets, generation related
regulatory assets, nuclear decommissioning and above market commitments under
current power purchase contracts. A December 19, 1997 order from FERC provides
Montaup, with full recovery of its stranded costs. Stranded costs are
recovered, via a Contract Termination Charge (CTC) under a contract termination
agreement which replaced the all-requirements contracts formerly in force
between Montaup and its retail affiliates. In its order, FERC approved
settlement agreements between Montaup, its retail affiliates and consumer
representatives in Massachusetts and Rhode Island. Both states' regulatory
bodies have approved retail settlements in accordance with enabling state
legislation. At December 31, 1997 Montaup estimated its stranded costs,
including unmitigated investment in owned generation, generation-related
regulatory assets, above-market purchase power commitments, nuclear
decommissioning and transition expenses to be approximately $1 billion on a
present value basis. This estimate is subject to significant uncertainties
including the future market price of electricity. See "Divestiture" below for
a discussion of stranded cost mitigation.
Rhode Island - Retail:
On August 7, 1996, the Governor of Rhode Island signed into law the
Utility Restructuring Act of 1996 (URA). The URA provides for customer choice
of electricity supplier in several phases commencing July 1, 1997 for certain
customers and culminating with choice for all customers by July 1, 1998, or
sooner. Under the URA, the local distribution company retains the
responsibility of providing distribution services to the ultimate electricity
consumer within its franchised service territory. For customers who do not
choose an alternative supplier, the local distribution company must arrange
for standard offer service. Distribution companies are providers of last
resort service for customers who are unable to obtain their own supply.
The URA provides for full recovery of stranded costs, through a non-
bypassable transition charge initially set at 2.8 cents per kWh through
December 31, 2000. The costs of net, above-market generation assets and
regulatory assets will be recovered, with a return, through a fixed component
of the transition charge from January 1, 1998, through December 31, 2009. A
variable component of the transition charge will recover, on a reconciling
basis, among other things, nuclear decommissioning and above market purchased
power commitments from January 1, 1998, through the life of the respective
unit or contract. The URA also provides for commitments to demand side
management initiatives and renewables, low-income customer protections,
divestiture of at least 15% of owned non-nuclear generating units as a
valuation basis for mitigation of stranded cost recovery, and performance-
based ratemaking (PBR) standards for electric distribution companies to be in
effect until the end of 1998.
In February 1997, Blackstone, Newport and Montaup reached a settlement in
principle with the Rhode Island Division of Public Utilities and Carriers
(RIDIV) and the state's Attorney General and filed a Memorandum of
Understanding (MOU) with the Rhode Island Public Utilities Commission (RIPUC),
outlining the terms of the settlement. The settlement was submitted to the
RIPUC in two separate filings which were approved on April 21, 1997 and
December 17, 1997, respectively. In addition to complying with the URA, the
settlement, similar in many respects to the settlement negotiated in
Massachusetts, described below, provided for, among other things, amendments to
Blackstone and Newport power contracts with Montaup to replace all-requirements
provisions with a CTC commensurate with retail access and the filing of a plan
to divest all of Montaup's generating assets. The net proceeds of the
divestiture will be used to mitigate the amount of Montaup's stranded costs to
be recovered through the CTC. See "Divestiture" below for a discussion of
Montaup's divestiture process.
On December 17, 1997, the RIPUC approved a retail settlement which
included a distribution rate freeze through December 31, 2000, except for any
temporary credit or surcharge resulting from PBR implementation or the standard
offer reconciliation, and retail access for all customers commencing January 1,
1998. In addition to the approval of wholesale power contract amendments by
FERC, received on December 19, 1997 (See "FERC -Wholesale" below), any
disposition of generation assets resulting from the agreements or the URA would
also require the approval of the Securities and Exchange Commission (SEC) under
the Public Utility Holding Company Act of 1935.
Massachusetts - Retail:
On December 23, 1996, Eastern Edison and Montaup reached an agreement in
principle with the Attorney General of Massachusetts and the Massachusetts
Department of Energy Resources (MADOER) and filed a MOU with the Massachusetts
Department of Telecommunications and Energy (DTE) (formerly the Department of
Public Utilities) outlining the terms of a plan, similar in many aspects to
the URA, which would allow retail customers to choose their supplier of
electricity in 1998 and provide Eastern Edison and Montaup full recovery of
stranded costs. On May 16, 1997 an Offer of Settlement was filed with the DTE.
The Offer of Settlement provided all of Eastern Edison's customers the
ability to choose an alternative supplier of electricity beginning as soon as
January 1, 1998. Until a customer chooses an alternative supplier, that
customer would receive standard offer service which would be priced to
guarantee at least a 10% reduction in electricity rates. Eastern Edison would
be required to arrange for standard offer service through December 31, 2004 and
would purchase power for standard offer service from suppliers through a
competitive bidding process. Montaup has guaranteed standard offer supply
at a fixed price schedule for the duration of the standard offer period. For
competitive suppliers to be eligible to provide supplies for standard offer
service, their prices must be competitive with the fixed prices guaranteed by
Montaup. In the event that some, or all, of the standard offer requirement is
not awarded to competitive suppliers, Montaup has an obligation to provide such
requirement at the indicated fixed price schedule, so called backstop service.
This backstop service will be assigned proportionately to purchasers of
Montaup's generating capacity. The agreement is also designed to achieve full
divestiture of Montaup's generating assets via implementation of a plan, that
would require (1) functional separation by Montaup of its generating and
transmission businesses, and (2) full market valuation and sale of all non-
nuclear assets through an auction or equivalent process.
On March 1, 1998, commensurate with retail choice in Massachusetts
Montaup's FERC-approved, all-requirements wholesale contract with Eastern
Edison was terminated. In its place, Montaup is billing Eastern Edison a CTC
designed to recover, among other things, Montaup's stranded costs. Eastern
Edison recovers the CTC through a non-bypassable transition access charge to
all of its distribution customers. The transition access charge will be
reduced by the fair market value of Montaup's generating assets as determined
by selling, spinning off, or otherwise disposing of such generating facilities.
See "Divestiture" below.
Embedded costs associated with generating plants and regulatory assets are
recovered, with a return, over a period of twelve years ending December 31,
2009. Purchased power contracts and nuclear decommissioning costs are
recovered as incurred over the life of those obligations, a period expected
to extend beyond twelve years. The initial transition access charge is set at
3.04 cents per kWh through December 31, 2000, and is expected to decline
thereafter.
The agreement also establishes a performance component for Eastern Edison,
incorporating a floor and cap on allowed return on equity. Under the
agreement, Eastern Edison's distribution rates are frozen until December 31,
2000. Subsequent to the commencement of retail choice, Eastern Edison's
annual return on equity is subject to a floor of 6% and a ceiling of 11.75%.
On November 25, 1997, the Governor of Massachusetts signed the Electric
Industry Restructuring Act (the Act) into law. The Act directed the DTE to
require electric companies to accommodate retail access to generation services
and choice of supplier by March 1, 1998 and to require electric companies to
file restructuring plans to do so. The Act also provides for a 10% reduction
in electric rates commencing March 1, 1998 and an additional 5% reduction,
adjusted for inflation, commencing September 1, 1999. The additional 5%
reduction may be accomplished with benefits from asset divestiture and/or
securitization.
On December 23, 1997 the DTE approved the Settlement as being in
substantial compliance with the Act. Retail access commenced on March 1, 1998
for Eastern Edison's retail customers.
In January 1998, several parties filed motions for reconsideration of
Eastern Edison's approved settlement agreement and motions to extend the
judicial appeal period with the DTE. The motions for reconsideration claim
that provisions of the approved plan involving consumer rates, cost recovery,
energy efficiency and reliability do not meet standards set forth in the Act.
The DTE denied one party's motions and that party has appealed the DTE's ruling
to the Massachusetts Supreme Judicial Court. Management cannot predict the
ultimate outcome of the pending motions for reconsideration or judicial
appeal.
The Office of the Attorney General has certified a referendum petition to
repeal the Act as a matter appropriate for a referendum initiative. A petition
was filed with the Election Division of the Office of the Secretary of State in
February 1998. A question on repealing the Act will be presented to voters on
the November 1998 ballot. EUA and the electric industry in Massachusetts will
actively oppose repeal. Management cannot predict the outcome of the November
ballot question.
FERC - Wholesale:
On May 1, 1997, Montaup and the R.I. Distribution Companies jointly filed
amendments to their FERC-approved all-requirements power contracts. The filing
included a calculation for a CTC to recover stranded costs and a provision for
standard offer service for resale to retail customers who do not choose an
alternate generation supplier as discussed under "Massachusetts-Retail" above.
These provisions replaced the services offered by the all-requirements
contracts upon full retail access pursuant to the URA. The filing also
included hold harmless provisions for Montaup's other wholesale customers
and for retail customers of the R.I. Distribution Companies and lost revenue
provisions, which allow for recovery of any of Montaup's lost revenues for the
period from the initial phases of retail access in Rhode Island through
completion of Montaup's divestiture process. This filing allowed the R.I.
Distribution Companies to implement on July 1, 1997, the phase-in provisions of
the URA and prevented any cross-subsidies by their retail customers who were
excluded from the groups of customers given retail choice prior to January 1,
1998 and by Montaup's other customers.
On May 30, 1997, elements of the Massachusetts Settlement Agreement,
including the CTC calculation, which fall under the jurisdiction of FERC were
filed with FERC.
The May 1st and May 30th filings were consolidated by FERC and on October
29, 1997, settlement agreements among Montaup, its affiliated and non-
affiliated customers, the Massachusetts Attorney General, the MADOER, the RIDIV
and RIPUC were submitted for FERC approval. These settlements represent a
comprehensive resolution of federal/wholesale issues of electric utility
industry restructuring based on the settlement agreements in Massachusetts and
Rhode Island. FERC approved the settlements on December 19, 1997,
accommodating retail choice for EUA's retail customers in Massachusetts and
Rhode Island.
Divestiture:
Montaup began marketing its portfolio of generation assets in July 1997,
and subsequently received bids from a number of potential purchasers. On
January 23, 1998, based on a review of the offers and discussions with
potential purchasers, Montaup announced that it was reopening the sales
process on the majority of its generating assets. The process is expected to
require four to six months to execute a purchase and sale agreement. The net
proceeds of the sale, as defined in the settlement agreements, will be used to
mitigate Montaup's CTC to its retail affiliates via a Residual Value Credit
(RVC). The RVC will reduce the fixed component of the CTC for the net
proceeds, with a return, in equal annual amounts over the period commencing on
the date the RVC is implemented through December 31, 2009. Subject to
regulatory approvals, Montaup anticipates the sale will be completed in early
1999.
Accounting Issues:
Historically, electric rates have been designed to recover a utility's
full cost of providing electric service including recovery of investment in
plant assets. Also, in a regulated environment, electric utilities are subject
to certain accounting rules that are not applicable to other industries. These
accounting rules allow regulated companies, in appropriate circumstances, to
establish regulatory assets and liabilities, which defer the current financial
impact of certain costs that are expected to be recovered in future rates. The
SEC has raised issues concerning the continued applicability of these standards
with certain other electric utilities in other states facing restructuring.
In July 1997, the Financial Accounting Standards Board's (FASB) Emerging
Issues Task Force (EITF) reached a consensus regarding certain issues raised
related to the application of Statement of Financial Accounting Standards No.
71 (FAS71), "Accounting for the Effects of Certain Types of Regulation." The
EITF determined that when sufficient detail is available for an enterprise to
reasonably determine, from legislation and enabling rate orders, how the
transition plan will affect the separable portion of its business being
deregulated, the enterprise should discontinue the application of FAS71 to
that deregulated portion of its business. The EITF also concluded that
utilities can continue to carry previously recorded regulatory assets on their
balance sheet if regulators have guaranteed a regulated cash flow stream to
recover the cost of those assets.
In light of approved restructuring settlement agreements and restructuring
legislation in both Massachusetts and Rhode Island, EUA has determined that
Montaup no longer will apply the provisions for FAS71 to the generation portion
of its business. Due to the recoverability of regulatory assets granted in the
approved restructuring plans, EUA believes that the discontinuation of FAS71
for the generation portion of Montaup's business will not have a material
impact on EUA's results of operation or financial condition. EUA believes its
transmission and retail distribution businesses continue to meet the criteria
for continued application of FAS71.
In addition, if legislative or regulatory changes and/or competition
result in electric rates which do not fully recover a company's costs, a write-
down of plant assets could be required pursuant to Financial Accounting
Standard No. 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed Of." EUA does not anticipate any write-down
of plant assets as a result of approved restructuring plans or enacted
legislation at this time.
Environmental Matters
Eastern Edison, Montaup and other companies owning generating units from
which power is obtained are subject, like other electric utilities, to
environmental and land use regulations at the federal, state and local levels.
The federal Environmental Protection Agency (EPA), and certain state and local
authorities, have jurisdiction over releases of pollutants, contaminants and
hazardous substances into the environment and have broad authority to set rules
and regulations in connection therewith, such as the Clean Air Act Amendments
of 1990, which could require installation of pollution control devices
and remedial actions. In 1994, EUA instituted an environmental audit program
designed to ensure compliance with environmental laws and regulations and to
identify and reduce liability with respect to those requirements.
Because of the nature of Eastern Edison's and Montaup's business, various
by-products and substances are produced or handled which are classified as
hazardous under the rules and regulations promulgated by such authorities.
Eastern Edison and Montaup typically provide for the disposal of such
substances through licensed contractors, but statutory provisions generally
impose potential joint and several responsibility on the generators of the
wastes for cleanup costs. In the past Eastern Edison and Montaup had been
notified with respect to a number of sites where they were allegedly
responsible for such costs, including sites where they allegedly had joint and
several liability with other responsible parties. Eastern Edison and Montaup
are currently not involved in any environmental site investigations.
It is the policy of the EUA System companies to notify liability insurers and
to initiate claims related to such costs.
A number of scientific studies in the past several years have examined the
possibility of health effects from electric and magnetic fields (EMF) that are
found wherever there is electricity. While some of the studies have indicated
some association between exposure to EMF and health effects, many others
have indicated no direct association. On October 31, 1996, the National
Academy of Sciences issued a literature review of all research to date,
"Possible Health Effects of Exposure to Residential Electric and Magnetic
Fields." Its most widely reported conclusion stated, "No clear, convincing
evidence exists to show that residential exposures to EMF are a threat to human
health." Additional studies, which are intended to provide a better
understanding of EMF, are continuing. Management cannot predict the ultimate
outcome of the EMF issue.
Nuclear Power Issues
Montaup has a 4.01% ownership interest in Millstone 3, an 1154-mw nuclear
unit that is jointly owned by a number of New England utilities, including
subsidiaries of Northeast Utilities (Northeast). Subsidiaries of Northeast
are the lead participants in Millstone 3. On March 30, 1996, it was necessary
to shut down the unit following an engineering evaluation which determined that
four safety-related valves would not be able to perform their design function
during certain postulated events.
The Nuclear Regulatory Commission (NRC) has raised numerous issues with
respect to the unit and certain of the other nuclear units operated by
Northeast. The NRC informed Northeast that it was establishing a Special
Projects Office to oversee inspection and licensing activities at Millstone and
directed Northeast to submit a plan for disposition of safety issues raised by
employees and retain an independent third-party to oversee implementation of
this plan.
In March of 1997, Northeast announced that Millstone 3 had been designated
as the lead unit in the recovery process of the three Millstone nuclear units
that are currently out of service. Millstone 3 is the largest of the three
units currently out of service, and its return to service will most benefit the
energy needs of the New England region.
On January 8, 1998, Northeast announced that Millstone 3 was "physically
ready for restart" indicating that virtually all of the restart-required
physical work had been completed. Northeast indicated that a small amount of
systems work needs to be completed prior to restart. Various NRC and
independent inspections are required prior to restart. EUA cannot predict when
the plant will be restarted. While Millstone 3 is out of service, Montaup will
continue to incur incremental replacement power costs estimated at up to $1
million per month.
Montaup has been paying its share of Millstone 3's O&M expenses on a
reservation of right basis. The fact that Montaup makes payment for these
expenses is not an admission of financial responsibility for expenses incurred
or to be incurred due to the outage.
In August 1997, nine non-operating owners, including Montaup, who together
own approximately 19.5% of Millstone 3, filed a demand for arbitration against
Connecticut Light and Power (CL&P) and Western Massachusetts Electric Company
(WMECO) as well as lawsuits against Northeast and its Trustees. CL&P and
WMECO, owners of approximately 65% of Millstone 3, are Northeast subsidiaries
which agreed to be responsible for the proper operation of the unit.
The non-operating owners of Millstone 3 claim that Northeast and its
subsidiaries failed to comply with NRC regulations, failed to operate the
facility in accordance with good utility operating practice and attempted to
conceal their activities from the non-operating owners and the NRC. The
arbitration and lawsuits seek to recover costs associated with replacement
power and O&M costs resulting from the shutdown of Millstone 3. The non-
operating owners conservatively estimate that their losses will exceed $200
million.
Montaup cannot predict the ultimate outcome of the NRC inquiries or legal
proceedings brought against CL&P, WMECO and Northeast or the impact which they
may have on Montaup and the EUA system.
On August 6, 1997, as the result of an economic evaluation, the Maine
Yankee Board of Directors voted to permanently close that nuclear plant.
Montaup has a 4.0% equity ownership in Maine Yankee with a book value of
approximately $3.2 million at December 31, 1997. Montaup's share of
the total estimated costs for the permanent shutdown, decommissioning, and
recovery of the remaining investment in Maine Yankee, is approximately $35.4
million and is included with Other Liabilities on the Consolidated Balance
Sheet for the period ending December 31, 1997. Also, due to anticipated
recoverability, a regulatory asset has been recorded for the same amount and is
included with Other Assets. The recovery of this estimated amount is subject
to approval of FERC. Montaup cannot predict the ultimate outcome of FERC's
review.
Also, as a result of the shutdown, Montaup and the other equity owners of
Maine Yankee have been notified by the Secondary Purchasers that they will no
longer make payments for purchased power to Maine Yankee. The Secondary
Purchase Contracts are between the equity owners as a group and 30
municipalities throughout New England. The equity owners are currently making
payments to Maine Yankee to cover the payments that would be made by the
municipals.
On November 28, 1997, the Secondary Purchasers sent a Notice of Initiation
of Arbitration to the equity owners of Maine Yankee. On December 15, 1997, the
equity owners as a group filed at FERC a Complaint and Petition for
Investigation, Contract Modification, and Declaratory Order. The equity
owners are seeking an order from FERC declaring that the Secondary Purchasers
remain responsible for payments due under the Purchase Contracts and directing
the Secondary Purchasers to make such payments. The equity owners also seek a
modification of the Purchase Contracts to extend the termination date or
otherwise to ensure that the equity owners may fully recover from the Secondary
Purchasers a share of the costs of shutting down and decommissioning the Maine
Yankee plant that is proportional to the Secondary Purchasers' entitlements to
energy from the plant. Management does not believe that this contract issue
will have a material effect on EUA's future operating results or financial
position and cannot predict its ultimate outcome at this time.
Recent actions by the NRC, some of which are cited above, indicate that
the NRC has become more critical and active in its oversight of nuclear power
plants. EUA is unable to predict at this time, what, if any, ramifications
these NRC actions will have on any of the other nuclear power plants in
which Montaup has an ownership interest or power contract.
Montaup is recovering through rates its share of estimated decommissioning
costs for the Millstone 3 and Seabrook I nuclear generating units. Montaup's
share of the currently allowed estimated total costs to decommission Millstone
3 is approximately $21.9 million in 1997 dollars and Seabrook I is
approximately $13.7 million in 1997 dollars. These figures are based on
studies performed for the lead owners of the units. Montaup also pays into
decommissioning reserves, pursuant to contractual arrangements, at other
nuclear generating facilities in which it has an equity ownership interest or
life-of-unit entitlement. Such expenses are currently recovered through rates.
In early 1998, Yankee Atomic, Maine Yankee and Connecticut Yankee,
individually, as well as a number of other utilities, filed suit in federal
appeals court seeking a court order to require the Department of Energy (DOE)
to immediately establish a program for the disposal of spent nuclear fuel.
Yankee Atomic and Connecticut Yankee are also seeking damages of approximately
$70 million and $90 million, respectively. Under the Federal Energy Policy Act
of 1992 and Nuclear Waste Policy Act, the DOE was to provide for the disposal
of radioactive wastes and spent nuclear fuel starting in 1998 and has collected
funds from owners of nuclear facilities to do so. Management cannot predict
the ultimate outcome of this issue.
Year 2000 Issue
The Company has conducted a comprehensive review of its computer systems
to identify the systems that could be affected by the Year 2000 Issue and is
developing an implementation plan to resolve the issue. The Year 2000 Issue is
the result of computer programs being written using two digits rather than four
to define the applicable year. Any programs that have time-sensitive software
may recognize a date using "00" as the year 1900 rather than the year 2000.
This could result in a major system failure or miscalculations. The Company
believes that, with modifications to existing software and conversions to new
software, the Year 2000 problem will not pose significant operational problems
for its computer systems as so modified and converted. It is anticipated that
all reprogramming efforts will be complete by the spring of 1999, allowing
adequate time for testing. In addition, notices have been sent to the
Company's primary processing vendors seeking assurance that plans are being
developed to address processing of transactions in the year 2000. Management
does not believe the year 2000 compliance expense will be material to the
Company's future operating results or future financial condition.
New Accounting Standards
In June 1997 the FASB issued Statement No. 130, "Reporting Comprehensive
Income," which establishes standards for reporting comprehensive income and its
components (revenues, expenses, gains, and losses) in a set of general-purpose
financial statements. This Statement requires that all items that are required
to be recognized under accounting standards as components of comprehensive
income be reported in a financial statement that is displayed with the same
prominence as other financial statements. This Statement is effective for
fiscal years beginning after December 15, 1997, and the Company will adopt
Statement 130 in the first quarter of 1998.
Other
The Company occasionally makes forward-looking projections of expected
future performance or statements of our plans and objectives. These forward-
looking statements may be contained in filings with the SEC, press releases and
oral statements. Actual results could differ materially from these statements.
Therefore, no assurances can be given that such forward-looking statements and
estimates will be achieved.
Management's Discussion and Analysis of Financial Condition and Review of
Operations provides a summary of information regarding the Company's financial
condition and results of operation and should be read in conjunction with the
"Consolidated Financial Statements" and "Notes to Consolidated Financial
Statements" in arriving at a more complete understanding of such matters.
Financial Table of Contents
Consolidated Statements of Income. . . . . . . . . . 16
Consolidated Statements of Retained Earnings . . . . . . 16
Consolidated Statements of Cash Flow . . . . . . . . . 17
Consolidated Balance Sheets . . . . . . . . . . . . . . 18
Consolidated Statements of Capitalization . . . . . . . 19
Notes to Consolidated Financial Statements . . . . . . . 21
Report of Independent Accountants . . . . . . . . . . . 36
Eastern Edison Company and Subsidiary
Consolidated Statements of Income
Years Ended December 31,
(In Thousands)
1997 1996 1995
Operating Revenues:
From Affiliated Companies $ 127,882 $ 127,981 $ 133,388
Other 307,132 276,827 286,681
Total Operating Revenues 435,014 404,808 420,069
Operating Expenses:
Fuel 110,717 92,159 90,881
Purchased Power - Demand 119,434 118,843 125,594
Other Operation and Maintenance 78,232 66,311 73,638
Affiliated Company Transactions 28,119 25,908 23,386
Voluntary Retirement Incentive 737 2,413
Depreciation and Amortization 27,489 26,810 26,039
Taxes - Other than Income 10,844 10,705 10,233
- Income 14,247 16,058 15,653
Total Operating Expenses 389,819 356,794 367,837
Operating Income 45,195 48,014 52,232
Equity in Earnings of Jointly Owned Comp. 1,599 1,587 1,646
Allowance for Other Funds Used During
Construction 162 365 473
Other Income (Deductions) - Net 666 1,583 407
Income Before Interest Charges 47,622 51,549 54,758
Interest Charges:
Interest on Long-Term Debt 15,006 15,233 18,277
Other Interest Expense 3,792 3,653 3,541
Allowance for Borrowed Funds Used During
Construction (Credit) (223) (308) (503)
Net Interest Charges 18,575 18,578 21,315
Net Income 29,047 32,971 33,443
Preferred Dividend Requirements 1,988 1,988 1,988
Consolidated Net Earnings Applicable to
Common Stock $ 27,059 $ 30,983 $ 31,455
Consolidated Statements of Retained Earnings
Years Ended December 31,
(In Thousands)
1997 1996 1995
Retained Earnings - Beginning of Year $ 120,724 $ 124,878 $ 105,574
Net Income 29,047 32,971 33,443
Amortization of Preferred Stock
Redemption Premium (577) (817) (961)
Total 149,194 157,032 138,056
Dividends Paid:
Preferred 1,988 1,988 1,988
Common 48,227 34,320 11,190
Retained Earnings - End of Year $ 98,979 $ 120,724 $ 124,878
The accompanying notes are an integral part of the financial statements.
Eastern Edison Company and Subsidiary
Consolidated Statements of Cash Flows
Years Ended December 31,
(In Thousands)
1997 1996 1995
CASH FLOW FROM OPERATING ACTIVITIES:
Net Income $ 29,047 $ 32,971 $ 33,443
Adjustments to Reconcile Net Income
to Net Cash Provided by Operating Activities:
Depreciation and Amortization 28,592 28,607 29,852
Amortization of Nuclear Fuel 1,067 1,676 3,647
Deferred Taxes (4,872) 5,217 2,694
Investment Tax Credit, Net (935) (939) (942)
Allowance for Funds Used During Constr. (162) (365) (473)
Other - Net (4,215) (2,333) 1,219
Changes to Operating Assets and Liabilities:
Accounts Receivable 10,038 (1,862) (7,055)
Fuel, Materials and Supplies 2,666 673 (1,678)
Accounts Payable 3,088 186 827
Accrued Taxes (653) (241) 1,807
Other - Net (2,282) 9,266 (6,630)
Net Cash Provided from Operating Activities 61,379 72,856 56,711
CASH FLOW FROM INVESTING ACTIVITIES:
Construction Expenditures (15,662) (26,006) (23,423)
Decrease in Other Investments 219 148
Net Cash (Used in) Investing Activities (15,443) (25,858) (23,423)
CASH FLOW FROM FINANCING ACTIVITIES:
Redemptions:
Long-Term Debt 0 (7,000) (35,000)
Common Stock Dividends Paid (48,227) (34,320) (11,190)
Preferred Dividends Paid (1,988) (1,988) (1,988)
Net Increase (Decrease) in Short Term
Debt 2,635 (2,118) 4,158
Net Cash (Used in) Financing Activities (47,580) (45,426) (44,020)
Net (Decrease) Increase in Cash
and Temporary Cash Investments (1,644) 1,572 (10,732)
Cash and Temporary Cash Investments at
Beginning of Year 2,105 533 11,265
Cash and Temporary Cash Investments at
End of Year $ 461 $ 2,105 $ 533
Cash paid during the year for:
Interest (Net of Amounts Capitalized) $ 13,993 $ 15,241 $ 18,343
Income Taxes $ 21,291 $ 13,267 $ 9,044
The accompanying notes are an integral part of the financial statements.
Eastern Edison Company and Subsidiary
Consolidated Balance Sheets
December 31,
(In Thousands)
ASSETS
1997 1996
Utility Plant and Other Investments:
Utility Plant $ 825,238 $ 817,992
Less Accumulated Provision for Depreciation 279,711 261,464
Net Utility Plant 545,527 556,528
Non-Utility Property - Net 2,705 2,705
Investment in Jointly Owned Companies 13,524 13,210
Other Investments (at cost) 55 95
Total Utility Plant and Other Investments 561,811 572,538
Current Assets:
Cash and Temporary Cash Investments 461 2,105
Accounts Receivable:
Customers 27,801 27,633
Others 4,486 3,464
Accrued Unbilled Revenue 8,490 8,376
Associated Companies 14,143 25,486
Fuel (at average cost) 4,248 6,844
Plant Materials and Operating Supplies (at aver. cost) 3,734 3,805
Prepayments and Other Current Assets 3,688 3,598
Total Current Assets 67,051 81,311
Other Assets (Note A) 148,262 121,233
Total Assets $ 777,124 $ 775,082
LIABILITIES AND CAPITALIZATION
Capitalization:
Common Equity $ 218,468 $ 240,213
Redeemable Preferred Stock - Net 29,665 29,665
Preferred Stock Redemption Cost (2,053) (2,630)
Long-term Debt - Net 162,491 222,402
Total Capitalization 408,571 489,650
Current Liabilities:
Long-term Debt Due Within One Year 60,000
Notes Payable 4,675 2,040
Accounts Payable:
Public 27,113 27,391
Associated Companies 7,317 3,950
Customer Deposits 1,258 1,153
Taxes Accrued 2,325 2,977
Interest Accrued 4,923 4,895
Other Current Liabilities 13,753 16,081
Total Current Liabilities 121,364 58,487
Other Liabilities 68,345 41,914
Deferred Credits:
Unamortized Investment Credit 15,967 16,903
Other Deferred Credits 23,402 25,689
Total Deferred Credits 39,369 42,592
Accumulated Deferred Taxes 139,475 142,439
Commitments and Contingencies (Note J)
Total Liabilities and Capitalization $ 777,124 $ 775,082
The accompanying notes are an integral part of the financial statements.
Eastern Edison Company and Subsidiary
Consolidated Statements of Capitalization
December 31,
(In Thousands)
1997 1996
Common Stock:
$25 par value, authorized and outstanding
2,891,357 shares $ 72,284 $ 72,284
Other Paid-In Capital 47,249 47,249
Common Stock Expense (44) (44)
Retained Earnings 98,979 120,724
Total Common Equity 218,468 240,213
Redeemable Preferred Stock:
6 5/8%, $100 par value, 300,000 shares (1) 30,000 30,000
Expense, Net of Premium (335) (335)
Preferred Stock Redemption Cost (2,053) (2,630)
Total Redeemable Preferred Stock 27,612 27,035
Long-Term Debt:
First Mortgage and Collateral Trust Bonds:
5 7/8% due 1998 20,000 20,000
6 7/8% due 2003 40,000 40,000
8% due 2023 40,000 40,000
5 3/4% due 1998 40,000 40,000
6.35% due 2003 8,000 8,000
7.78% Secured Medium-Term Notes due 2002 35,000 35,000
Pollution Control Revenue Bond:
5 7/8% due 2008 40,000 40,000
Unamortized (Discount) - Net (509) (598)
222,491 222,402
Less Portion Due Within One Year 60,000
Total Long-Term Debt 162,491 222,402
Total Capitalization $ 408,571 $ 489,650
(1) Authorized and Outstanding.
The accompanying notes are an integral part of the financial statements.
[This page left blank intentionally]
EASTERN EDISON COMPANY AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997, 1996, and 1995
(A) Nature of Operations and Summary of Significant Accounting Policies:
General: Eastern Edison Company (Eastern Edison or the Company) and its
wholly owned subsidiary, Montaup Electric Company (Montaup) are principally
engaged in the generation, transmission, distribution and sale of electric
energy.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
The accounting policies and practices of Eastern Edison and of Montaup are
subject to regulation by the Federal Energy Regulatory Commission (FERC) and
the Massachusetts Department of Telecommunications and Energy (formerly
Massachusetts Department of Public Utilities) with respect to their rates and
accounting. Eastern Edison and Montaup conform with generally accepted
accounting principles, as applied in the case of regulated public utilities,
and conform with the accounting requirements and ratemaking practices of the
regulatory authority having jurisdiction.
Principles of Consolidation: The consolidated financial statements include
the accounts of Eastern Edison and its subsidiary, Montaup. All material
intercompany balances and transactions have been eliminated in consolidation.
Jointly Owned Companies: Montaup Electric Company (Montaup) follows the
equity method of accounting for its stock ownership investments in jointly
owned companies including four regional nuclear generating companies.
Montaup's investments in these nuclear generating companies range from 2.5% to
4.5%. Three of the four facilities have been permanently shut down and are in
the process of decommissioning. Montaup is entitled to electricity produced
from the remaining facility based on its ownership interest and is billed for
its entitlement pursuant to a contractual agreement which is approved by FERC.
In December 1996, the Board of Directors of Connecticut Yankee voted to
retire the generating station. Connecticut Yankee certified to the Nuclear
Regulatory Commission (NRC) that it had permanently closed power generation
operations and removed fuel from the reactor. Montaup has a 4.5% equity
ownership in Connecticut Yankee. Montaup's share of the total estimated costs
for the permanent shutdown, decommissioning, and recovery of the investment in
Connecticut Yankee is approximately $27.4 million and is included with Other
Liabilities on the Consolidated Balance Sheet as of December 31, 1997. Also,
due to recoverability, a regulatory asset has been recorded for the same amount
and is included with Other Assets. The recovery of this estimated amount,
elements of which have been disputed by certain intervening parties, is subject
to approval of FERC. Montaup cannot predict the ultimate outcome of FERC's
review.
In August 1997, as the result of an economic evaluation, the Maine Yankee
Board of Directors voted to permanently close that nuclear plant. Montaup has
a 4.0% equity ownership in Maine Yankee. Montaup's share of the total
estimated costs for the permanent shutdown, decommissioning, and recovery of
the remaining investment in Maine Yankee is approximately $35.4 million and is
included with Other Liabilities on the Consolidated Balance Sheet as of
December 31, 1997. Also, due to recoverability, a regulatory asset has been
recorded for the same amount and is included with Other Assets. The recovery
of this estimated amount, elements of which have been disputed by certain
intervening parties, is subject to approval of FERC. Montaup cannot predict
the ultimate outcome of FERC's review.
Montaup also has a stock ownership investment of 3.27% in each of the two
companies which own and operate certain interconnection facilities used to
transmit hydroelectric power between the Hydro-Quebec Electric System and New
England.
Transactions with Affiliates: Eastern Edison is a wholly owned subsidiary of
Eastern Utilities Associates (EUA). In addition to its investment in Eastern
Edison, EUA has interests in two other retail companies, a service corporation,
and five other non-utility companies.
Transactions between Montaup and other affiliated companies include the
following: sales of electricity by Montaup to Blackstone Valley Electric
Company (Blackstone) and Newport Electric Corporation (Newport) aggregating
approximately $127,882,000 in 1997, $127,536,000 in 1996, and $133,841,000 in
1995; accounting, engineering and other services rendered by EUA Service
Corporation to Eastern Edison and Montaup of approximately $32,190,000,
$30,886,000, and $29,264,000, in 1997, 1996 and 1995, respectively; and
operating expense from the rental of transmission and generation facilities by
Blackstone and Newport to Montaup aggregating approximately $4,197,000 in 1997,
$3,960,000 in 1996, and $4,351,000 in 1995. Transactions with affiliated
companies are subject to review by applicable regulatory commissions.
Utility Plant and Depreciation: Utility plant is stated at original cost.
The cost of additions to utility plant includes contracted work, direct labor
and material, allocable overhead, allowance for funds used during construction
and indirect charges for engineering and supervision. For financial statement
purposes, depreciation is computed on the straight-line method based on
estimated useful lives of the various classes of property. Provisions for
depreciation, on a consolidated basis, were equivalent to a composite rate of
approximately 3.2% in 1997, 1996 and 1995 based on the average depreciable
property balances at the beginning and end of each year. Beginning in 1998,
coincident with billing a contract termination charge (CTC) to its retail
affiliates, Montaup will commence depreciating its investment in generation
related assets recoverable through the CTC over a twelve-year period.
Other Assets: The components of Other Assets at December 31, 1997 and 1996
are detailed as follows:
(In Thousands) 1997 1996
Regulatory Assets:
Unamortized losses on reacquired debt $ 11,588 $ 13,277
Unrecovered plant and
decommissioning cost 68,345 41,914
Deferred SFAS 109 costs (Note B) 46,806 47,326
Deferred SFAS 106 costs (Note J) 1,726 2,153
Other regulatory assets 5,875 4,886
Total regulatory assets 134,340 109,556
Other deferred charges and assets:
Unamortized debt expenses 2,092 2,456
Other 11,830 9,221
Total Other Assets $148,262 $121,233
Regulatory Accounting: Eastern Edison and Montaup are subject to certain
accounting rules that are not applicable to other industries. These accounting
rules allow regulated companies, in appropriate circumstances, to establish
regulatory assets and liabilities which defer the current financial impact of
certain costs that are expected to be recovered in future rates. In light of
approved restructuring settlement agreements and restructuring legislation in
both Massachusetts and Rhode Island, the Company has determined that Montaup no
longer will apply the provisions of Financial Accounting Standards Board's
(FASB) Statement of Financial Accounting Standards No. 71 (FAS71), "Accounting
for the Effects of Certain Types of Regulation" to the generation portion of
its business. Due to the recoverability of regulatory assets granted in the
approved restructuring plans, the company believes that the discontinuation of
FAS71 for the generation portion of Montaup's business will not have a material
impact on the Company's results of operation or financial condition. The
Company believes its transmission and retail distribution businesses continue
to meet the criteria for continued application of FAS71.
Allowance for Funds Used During Construction (AFUDC): AFUDC represents the
estimated cost of borrowed and equity funds used to finance Eastern Edison's
and Montaup's construction program. In accordance with regulatory accounting,
AFUDC is capitalized, as a cost of utility plant, in the same manner as certain
general and administrative costs. AFUDC is not an item of current cash income,
but is recovered over the service life of utility plant in the form of
increased revenues collected as a result of higher depreciation expense. The
combined rate used in calculating AFUDC was 8.2% in 1997; 8.9% in 1996, and
9.4% in 1995.
Operating Revenues: Revenues are based on billing rates authorized by
applicable federal and state regulatory commissions. Eastern Edison accrues
the estimated amount of unbilled revenues at the end of each month to match
costs and revenues more closely. Montaup recognizes revenues when billed. In
1998, Eastern Edison and Montaup also began accruing revenues consistent with
provisions of approved settlement agreements and the Massachusetts Electric
Industry Restructuring Act.
Income Taxes: The general policy of Eastern Edison and Montaup with respect
to accounting for federal and state income taxes is to reflect in income the
estimated amount of taxes currently payable, as determined from the EUA
consolidated tax return on an allocated basis, and to provide for deferred
taxes on certain items subject to temporary differences to the extent permitted
by the various regulatory commissions. As permitted by the regulatory
commissions, it is the policy of Eastern Edison and Montaup to defer
recognition of the annual investment tax credits and to amortize these credits
over the productive lives of the related assets. Beginning in 1998, Montaup
will amortize previously deferred ITC related to generation investments
recoverable through the CTC over a twelve-year period.
Cash and Temporary Cash Investments: Eastern Edison and Montaup consider all
highly liquid investments and temporary cash investments with a maturity of
three months or less, when acquired, to be cash equivalents.
(B) Income Taxes:
Components of income tax expense for the years 1997, 1996, and 1995 are as
follows:
_________________________________________________________________________
(In Thousands) 1997 1996 1995
Federal:
Current $16,427 $ 9,111 $11,387
Deferred (4,031) 5,152 3,679
Investment Tax Credit, Net (935) (939) (942)
$11,461 $13,324 $14,124
State:
Current 3,505 2,612 2,447
Deferred (719) 122 (918)
2,786 2,734 1,529
Charged to Operations 14,247 16,058 15,653
Charged to Other Income:
Current 1,175 1,233 522
Deferred (219) (67) (67)
Total $15,203 $17,224 $16,108
Total income tax expense was different than the amounts computed by
applying federal income tax statutory rates to book income subject to tax for
the following reasons:
______________________________________________________________________________
(In Thousands) 1997 1996 1995
Federal Income Tax Computed
at Statutory Rates $15,487 $17,568 $17,343
(Decreases) Increases in Tax from:
Equity Component of AFUDC (56) (128) (165)
Consolidated Tax Savings (156) (108)
Depreciation Differences (348) (452) (264)
Amortization and Utilization
of ITC (935) (939) (942)
State Taxes, Net of Federal
Income Tax Benefit 1,919 1,897 (2,625)
Cost of Removal 58
Other (864) (566) 2,811
Total Income Tax Expense $15,203 $17,224 $16,108
Eastern Edison and Montaup adopted Statement of Financial Accounting
Standard No. 109, "Accounting for Income Taxes" (FAS109) which required
recognition of deferred income taxes for temporary differences that are
reported in different years for financial reporting and tax purposes using the
liability method. Under the liability method, deferred tax liabilities or
assets are computed using the tax rates that will be in effect when temporary
differences reverse. Generally, for regulated companies, the change in tax
rates may not be immediately recognized in operating results because of rate
making treatment and provisions in the Tax Reform Act of 1986. The total
deferred tax assets and liabilities at December 31, 1997 and 1996 are comprised
as follows (In Thousands):
Deferred Tax Deferred Tax
Assets Liabilities
1997 1996 1997 1996
Plant Related Plant Related
Differences $11,997 $13,490 Differences $154,025 $153,471
Alternative Refinancing
Minimum Tax 412 Costs 1,264 1,471
Pensions 1,837 1,299 Pensions 987 877
Other 5,974 1,040 Other 3,007 2,507
Total $19,808 $16,241 Total $159,283 $158,326
As of December 31, 1997 and 1996, the Company had recorded on its
Consolidated Balance Sheet a regulatory liability to ratepayers of
approximately $15.2 million and $18.0 million, respectively. This amount
primarily represents excess deferred income taxes resulting from the
reduction in the federal income tax rate and also includes deferred taxes
provided on investment tax credits. Also at December 31, 1997 and 1996, a
regulatory asset of approximately $46.8 million and $47.3 million,
respectively, has been recorded, representing the cumulative amount of federal
income taxes on temporary depreciation differences which were previously flowed
through to ratepayers.
(C) Capital Stock:
There were no changes in the number of shares of common or preferred stock
during the years ended December 31, 1997, 1996 and 1995.
Under the terms and provisions of the issues of preferred stock of Eastern
Edison, certain restrictions are placed upon the payment of dividends on common
stock by Eastern Edison. At December 31, 1997, 1996 and 1995, the respective
capitalization ratios were in excess of the minimum requirements which would
make these restrictions effective.
(D) Redeemable Preferred Stock
Eastern Edison's 6-5/8% Preferred Stock issue is entitled to an annual
mandatory sinking fund sufficient to redeem 15,000 shares commencing September
1, 2003. The redemption price is $100 per share plus accrued dividends. All
outstanding shares of the 6-5/8% issue will be subject to mandatory redemption
on September 1, 2008 at a price of $100 per share plus accrued dividends.
In the event of liquidation, the holders of Eastern Edison's 6-5/8%
Preferred Stock are entitled to $100 per share plus accrued dividends.
(E) Retained Earnings:
Under the provisions of Eastern Edison's Indenture securing the First
Mortgage and Collateral Trust Bonds, retained earnings in the amount of
$96,218,056 as of December 31, 1997 were unrestricted as to the payment of cash
dividends on its Common Stock.
(F) Long-Term Debt:
The various mortgage bond issues of Eastern Edison are collateralized by
substantially all of their utility plant. In addition, Eastern Edison's bonds
are collateralized by securities of Montaup, which are wholly-owned by Eastern
Edison, in the principal amount of approximately $236 million.
The Company's aggregate amount of current cash sinking fund requirements
and maturities of long-term debt, (excluding amounts that may be satisfied by
available property additions) for each of the five years following 1997 are:
$60 million in 1998, and none in 1999, 2000, 2001 and $35 million in 2002.
(G) Lines of Credit:
In July 1997, several EUA System companies, including Eastern Edison,
entered into a three-year revolving credit agreement allowing for borrowings in
aggregate of up to $120 million. As of December 31, 1997, various financial
institutions have committed up to $75 million under the revolving credit
facility. At December 31, 1997, under the revolving credit agreement the EUA
System had short-term borrowings available of approximately $13.5 million.
Eastern Edison had $4.7 million of outstanding short-term debt at December 31,
1997. In accordance with the revolving credit agreement commitment fees are
required to maintain certain lines of credit. During 1997, the weighted
average interest rate for short-term borrowings by the Company was 5.8%.
(H) Jointly Owned Facilities:
At December 31, 1997, in addition to the stock ownership interests
discussed in Note A, Summary of Significant Accounting Policies - Jointly Owned
Companies, Montaup had direct ownership interests in the following electric
generating facilities:
Accumulated
Provision For Net Construc-
Utility Depreciation Utility tion
Percent Plant in and Plant in Work in
Owned Service Amortization Service Progress
($ In Thousands):
Montaup:
Canal Unit 2 50.00% $ 85,750 $ 44,498 $ 41,252 $ 227
Wyman Unit 4 1.96% 4,054 2,253 1,801
Seabrook Unit I 2.90% 194,679 34,400 160,279 325
Millstone Unit 3 4.01% 178,918 54,844 124,074 285
The foregoing amounts represent Montaup's interest in each facility,
including nuclear fuel where appropriate, and are included on the like-
captioned lines on the Consolidated Balance Sheet. At December 31, 1997,
Montaup's total net investment in nuclear fuel of the Seabrook and Millstone
units amounted to $2.2 million and $1.8 million, respectively. Montaup's
shares of related operating and maintenance expenses with respect to units
reflected in the table above are included in the corresponding operating
expenses on the Consolidated Statement of Income.
(I) Fair Value of Financial Instruments:
The following methods and assumptions were used to estimate the fair value
of each class of financial instruments for which it is practicable to estimate:
Cash and Temporary Cash Investments: The carrying amount approximates
fair value because of the short-term maturity of those instruments.
Redeemable Preferred Stock and Long-Term Debt: The fair value of the
Company's redeemable preferred stock and long-term debt were based on quoted
market prices for such securities.
The estimated fair values of the Company's financial instruments at
December 31, 1997 and 1996 were as follows (In Thousands):
Carrying Amount Fair Value
1997 1996 1997 1996
Cash and Temporary Cash Investments $ 461 $ 2,105 $ 461 $ 2,105
Redeemable Preferred Stock 30,000 30,000 31,613 30,300
Long-Term Debt $223,000 $223,000 $235,190 $225,870
(J) Commitments and Contingencies:
Nuclear Fuel Disposal and Nuclear Decommissioning Costs: The owners (or lead
participants) of the nuclear units in which Montaup has an interest have made,
or expect to make, various arrangements for the acquisition of uranium
concentrate, the conversion, enrichment, fabrication and utilization of nuclear
fuel and the disposition of that fuel after use. The owners (or lead
participants) of United States nuclear units have entered into contracts with
the Department of Energy (DOE) for disposal of spent nuclear fuel in accordance
with the Nuclear Waste Policy Act of 1982 (NWPA). The NWPA requires (subject
to various contingencies) that the federal government design, license,
construct and operate a permanent repository for high level radioactive
wastes and spent nuclear fuel and establish a prescribed fee for the disposal
of such wastes and nuclear fuel. The NWPA specifies that the DOE provide for
the disposal of such waste and spent nuclear fuel starting in 1998. Objections
on environmental and other grounds have been asserted against proposals for
storage as well as disposal of spent nuclear fuel. The DOE now estimates that
a permanent disposal site for spent fuel will not be ready to accept fuel for
storage or disposal until as late as the year 2010. In early 1998 a number of
utilities filed suit in federal appeals court seeking, among other things, an
order requiring the DOE to immediately establish a program for the disposal
of spent nuclear fuel. Montaup owns a 4.01% interest in Millstone 3 and a 2.9%
interest in Seabrook I. Northeast Utilities, the operator of the units,
indicates that Millstone 3 has sufficient on-site storage facilities which,
with rack additions, can accommodate its spent fuel for the projected life
of the unit. At the Seabrook Project, there is on-site storage capacity which,
with rack additions, will be sufficient to at least the year 2011.
The Energy Policy Act of 1992 requires that a fund be created for the
decommissioning and decontamination of the DOE uranium enrichment facilities.
The fund will be financed in part by special assessments on nuclear power
plants in which Montaup has an interest. These assessments are calculated
based on the utilities' prior use of the government facilities and have been
levied by the DOE, starting in September 1993, and will continue over 15 years.
This cost is passed on to the joint owners or power buyers as an additional
fuel charge on a monthly basis and is currently being recovered by Montaup
through rates.
Also, Montaup is recovering through rates its share of estimated
decommissioning costs for Millstone 3 and Seabrook I. Montaup's share of the
current estimate of total costs to decommission Millstone 3 is $21.9 million in
1997 dollars, and Seabrook I is $13.7 million in 1997 dollars. These figures
are based on studies performed for the lead owners of the units. Montaup also
pays into decommissioning reserves pursuant to contractual arrangements with
other nuclear generating facilities in which it has an equity ownership
interest or life of the unit entitlement. Such expenses are currently
recoverable through rates.
Pensions: Eastern Edison and Montaup participate with the other EUA
System companies in a non-contributory defined benefit pension plan covering
substantially all of their employees (Retirement Plan). Retirement Plan
benefits are based on years of service and average compensation over the four
years prior to retirement. It is the EUA System's policy to fund the
Retirement Plan on a current basis in amounts determined to meet the funding
standards established by the Employee Retirement Income Security Act of 1974.
Total pension (income) expense for the Retirement Plan, including amounts
related to the 1997 and 1995 voluntary retirement incentive offers, for 1997,
1996 and 1995 includes the following components ($ In Thousands):
1997 1996 1995
Service cost - benefits earned during
the period $ 1,689 $ 1,713 $ 1,504
Interest cost on projected benefit
obligation 6,021 5,767 5,575
Actual (return) loss on assets (18,178) (10,036) (22,158)
Net amortization and deferrals 9,891 2,407 14,855
Net periodic pension income $ (577) $ (149) $ (224)
Voluntary retirement incentive 857
Total periodic pension (income) expense $ (577) $ (149) $ 633
Assumptions used to determine pension cost:
1997 1996 1995
Discount Rate 7.50% 7.25% 8.25%
Compensation Increase Rate 4.25% 4.25% 4.75%
Long-Term Return on Assets 9.50% 9.50% 9.50%
The discount rate used to determine pension obligations was changed to
7.25% effective January 1, 1998. The funded status of the Retirement Plan
cannot be presented separately for Eastern Edison and Montaup as they
participate in the Retirement Plan with other subsidiaries of EUA.
The voluntary retirement incentives also resulted in non-qualified pension
benefits of approximately $752,000 and $800,000 in 1997 and 1995, respectively.
At December 31, 1997, approximately $448,000 is included in other liabilities
for these unfunded benefits.
EUA also maintains non-qualified supplemental retirement plans for certain
officers and trustees of the EUA System (Supplemental Plans). Benefits
provided under the Supplemental Plans are based primarily on compensation at
retirement date. EUA maintains life insurance on the participants of the
Supplemental Plans to fund in whole, or in part, its future liabilities under
the Supplemental Plans. For the years ended December 31, 1997, 1996 and 1995
Eastern Edison's and Montaup's expenses related to the Supplemental Plan were
approximately $805,000, $717,000 and $825,000, respectively.
The Company also provides a defined contribution 401(k) savings plan for
substantially all employees. The Company's matching percentage of employees'
voluntary contributions to the plan, amounted to approximately $321,000 in
1997, $306,000 in 1996, and approximately $369,000 in 1995.
Post-Retirement Benefits: Retired employees are entitled to participate in
health care and life insurance benefit plans. Health care benefits are subject
to deductibles and other limitations. Health care and life insurance benefits
are partially funded by EUA System companies for all qualified employees.
Eastern Edison and Montaup adopted FAS106, "Employers' Accounting for
Post-Retirement Benefits Other Than Pensions," as of January 1, 1993. This
standard establishes accounting and reporting standards for such post-
retirement benefits as health care and life insurance. Under FAS106 the
present value of future benefits is recorded as a periodic expense over
employee service periods through the date they become fully eligible for
benefits. With respect to periods prior to adopting FAS106, EUA elected to
recognize accrued costs (the Transition Obligation) over a period of 20 years,
as permitted by FAS106. The resultant annual expense, including amortization
of the Transition Obligation and net of amounts capitalized and deferred, was
approximately $3.9 million in 1997, $3.6 million in 1996 and $4.0 million in
1995.
The total cost of Post-Retirement Benefits other than Pensions, including
amounts related to the 1997 and 1995 voluntary retirement incentive offers, for
1997, 1996 and 1995 includes the following components (In Thousands):
1997 1996 1995
Service cost $587 $637 $565
Interest cost 2,701 2,688 2,926
Actual return on plan assets (775) (115) (388)
Amortization of transition obligation 1,952 1,955 1,965
Net other amortization & deferrals (407) (721) (632)
Net periodic post-retirement benefit costs 4,058 4,444 4,436
Voluntary retirement incentive 102 470
Total post-retirement benefit costs $4,160 $4,444 $4,906
Assumptions:
Discount rate 7.50% 7.25% 8.25%
Health care cost trend rate - near-term 7.00% 9.00% 11.00%
- long-term 5.00% 5.00% 5.00%
Compensation increase rate 4.25% 4.25% 4.75%
Rate of return on plan assets - union 8.50% 8.50% 8.50%
- non-union 7.50% 7.50% 5.50%
Reconciliation of funded status:
1997 1996 1995
(In Thousands)
Accumulated post-retirement benefit obligation (APBO):
Retirees $(20,819) ($19,864) $(23,223)
Active employee fully eligible for benefits (1,551) (1,728) (3,649)
Other active employees (6,101) (6,031) (7,711)
Total (28,471) (27,623) (34,583)
Fair Value of assets (primarily notes and bonds) 6,991 5,161 3,830
Unrecognized transition obligation 24,463 26,095 27,726
Unrecognized net gain (8,924) (9,297) (2,142)
(Accrued) prepaid post-retirement benefit cost $(5,941) $5,664 $ (5,169)
The discount rate and compensation increase rates used to determine post-
retirement benefit obligations was changed to 7.25% effective January 1, 1998,
and was used to calculate the funded status of Post-Retirement Benefits at
December 31, 1997.
Increasing the assumed health care cost trend rate by 1% each year would
increase the total post-retirement benefit cost for 1997 by approximately
$299,000 and increase the total accumulated post-retirement benefit obligation
by approximately $2.9 million.
Eastern Edison and Montaup have also established an irrevocable external
Voluntary Employees' Beneficiary Association (VEBA) Trust Fund. Contributions
to the VEBA fund commenced in March 1993 and contributions were made totaling
approximately $2.9 million in 1997 and 1996, and $3.2 million in 1995.
Long-Term Purchased Power Contracts: Montaup is committed under long-term
purchased power contracts, expiring on various dates through September 2021, to
pay demand charges whether or not energy is received. Under terms in effect at
December 31, 1997, the aggregate annual minimum commitments for such contracts
are approximately $114 million in 1998, $110 million in 1999, $107 million in
2000, $108 million in 2001, $108 million in 2002, and will aggregate $1.0
billion for the ensuing years. In addition, the EUA System is required to pay
additional amounts depending on the actual amount of energy received under such
contracts. The demand costs associated with these contracts are reflected as
Purchased Power-Demand on the Consolidated Statement of Income. Such costs are
currently recoverable through rates.
Environmental Matters: There is an extensive body of federal and state
statutes governing environmental matters, which permit, among other things,
federal and state authorities to initiate legal action providing for liability,
compensation, cleanup, and emergency response to the release or threatened
release of hazardous substances into the environment and for the cleanup of
inactive hazardous waste disposal sites which constitute substantial hazards.
Because of the nature of the Eastern Edison business, various by-products and
substances are produced or handled which are classified as hazardous under the
rules and regulations promulgated by the United States Environmental Protection
Agency (EPA) as well as state and local authorities. The Company generally
provides for the disposal of such substances through licensed contractors, but
these statutory provisions generally impose potential joint and several
responsibility on the generators of the wastes for cleanup costs. In the past,
Eastern Edison and Montaup had been notified with respect to a number of sites
where they were allegedly responsible for such costs, including sites where
they allegedly had joint and several liability with other responsible parties.
Eastern Edison and Montaup are currently not involved in any environmental site
investigation. It is the policy of Eastern Edison and Montaup to notify
liability insurers and to initiate claims. The costs incurred in connection
with these sites have been financed primarily with internally generated cash.
As a general matter Eastern Edison and Montaup would seek to recover costs
relating to environmental proceedings in their rates. Montaup is currently
recovering certain of the incurred costs in its rates.
The Clean Air Act Amendments created new regulatory programs and generally
updated and strengthened air pollution control laws. These amendments expanded
the regulatory role of the EPA regarding emissions from electric generating
facilities and a host of other sources. EUA System generating facilities were
first affected in 1995, when EPA regulations took effect for facilities.
Montaup's coal-fired Somerset Unit 6 is utilizing lower sulfur content coal to
meet the 1995 air standards. EUA does not anticipate the impact from the
Amendments to be material to the financial position of the EUA System.
In July, the EPA issued a new and more stringent rule covering ozone
particulate matter which is to be followed by promulgation of more stringent
ozone and particulate matter standards. The effect that such standards will
have on the EUA System cannot be determined by management at this time.
Eastern Edison, Montaup, the Massachusetts Attorney General and Division
of Energy Resources entered into a settlement regarding electric utility
industry restructuring in Massachusetts. The settlement includes a plan for
emissions reductions related to Montaup's Somerset Station Units
5 and 6, and to Montaup's 50% ownership share of Canal Electric's Unit 2. The
basis for SO2 and NOx emission reductions in the proposed settlement is an
allowance cap calculation. Montaup may meet its allowance caps by any
combination of control technologies, fuel switching, operational changes,
and/or the use of purchased or surplus allowances. The settlement was approved
by FERC on December 19, 1997.
In April 1992, the Northeast States for Coordinated Air Use Management
(NESCAUM), an environmental advisory group for eight northeast states including
Massachusetts and Rhode Island, issued recommendations for NOx controls for
existing utility boilers required to meet the ozone non-attainment requirements
of the Clean Air Act. The NESCAUM recommendations are more restrictive than
the Clean Air Act requirements. The Massachusetts Department of Environmental
Management has amended its regulations to require that Reasonably Available
Control Technology (RACT) be implemented at all stationary sources potentially
emitting 50 tons or more per year of NOx. Similar regulations have been issued
in Rhode Island. Montaup has initiated compliance, through, among other
things, selective noncatalytic reduction processes.
A number of scientific studies in the past several years have examined the
possibility of health effects from EMF that are found wherever there is
electricity. While some of the studies have indicated some association between
exposure to EMF and health effects, many others have indicated no direct
association. On October 31, 1996, the National Academy of Sciences issued a
literature review of all research to date, Possible Health Effects of Exposure
to Residential Electric and Magnetic Fields. Its most widely reported
conclusion stated, "No clear, convincing evidence exists to show that
residential exposures to EMF are a threat to human health." Additional studies,
which are intended to provide a better understanding of EMF, are continuing.
Some states have enacted regulations to limit the strength of magnetic
fields at the edge of transmission line rights-of-way. Rhode Island has
enacted a statute which authorizes and directs the Energy Facility Siting Board
to establish rules and regulations governing construction of high voltage
transmission lines of 69 kv or more. Management cannot predict the ultimate
outcome of the EMF issue.
Guarantee of Financial Obligations: Montaup is a 3.27% equity participant in
two companies which own and operate transmission facilities interconnecting New
England and the Hydro Quebec system in Canada. Montaup has guaranteed
approximately $4.5 million of the outstanding debt of these two companies. In
addition, Montaup has a minimum rental commitment which totals approximately
$12.0 million under a noncancellable transmission facilities support agreement
for years subsequent to 1997.
Other: In early 1997, ten plaintiffs brought suit against numerous
defendants, including EUA, for injuries and illness allegedly caused by
exposure to asbestos over approximately a thirty-year period, at premises,
including some owned by EUA companies. The total damages claimed in all
of these complaints was $25 million in compensatory and punitive damages, plus
exemplary damages and interest and costs. Each names between fifteen and
twenty-eight defendants, including EUA. These complaints have been referred to
the applicable insurance companies. Counsel has been retained by the insurers
and is actively defending all cases. Three cases have been dismissed
as against EUA companies with prejudice. EUA cannot predict the ultimate
outcome of this matter at this time.
The Office of the Attorney General has certified a referendum petition to
repeal the Massachusetts Electric Industry Restructuring Act as a matter
appropriate for a referendum initiative. A petition was filed with the
Election Division of the Office of the Secretary of State in February
1998. A question on repealing the Act will be presented to voters on the
November 1998 ballot.
EUA and the electric industry in Massachusetts will actively oppose repeal.
Management cannot predict the outcome of the November ballot question.
Report of Independent Accountants
To the Directors and Shareholder of
Eastern Edison Company and Subsidiary:
We have audited the accompanying consolidated balance sheets and consolidated
statements of capitalization of Eastern Edison Company and its subsidiary (the
Company) as of December 31, 1997 and 1996, and the related consolidated
statements of income, retained earnings and cash flows for each of the three
years in the period ended December 31, 1997. These financial statements are
the responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of the Company as of December 31,
1997 and 1996, and the results of its operations and its cash flows for each of
the three years in the period ended December 31, 1997 in conformity with
generally accepted accounting principles.
Coopers & Lybrand L.L.P.
Boston, Massachusetts
March 3, 1998